As I scanned over the sea of red in my watch list last week, a green light shone through like a ray of hope. It was my old friend VCA Antech
VCA Antech is a special little company. It operates the nation's largest veterinary business, while simultaneously providing the most comprehensive laboratory services for the pet health-care industry. The company's more than 435 animal hospitals in 38 states provide the industry's broadest coverage, employing more than 1,600 veterinarians and more than 130 board-certified specialists. Through Antech Diagnostics, the company also offers a nationwide network of laboratories to serve the growing diagnostic needs of vets and pet owners alike.
I learned from Peter Lynch that companies competing in fragmented markets against mom-and-pop shops tend to gain advantages from economies of scale. In that regard, VCA has a nice little niche to grow into. Americans spent roughly $18 billion on animal health-care services in 2004, because 63% of U.S. households own at least one pet. Even though VCA leads the industry, it operates in a fragmented market comprising more than 22,000 hospitals nationwide. In short, there's plenty of room to grow.
And grow it does, aiming to add 20-25 hospitals and increase revenue by $35 million to $40 million per year, mostly through acquisitions. Sometimes it will do larger deals, such as this summer's $153 million acquisition of Healthy Pet, which operated 44 veterinary hospitals and generated revenue of $80 million.
In its acquisitions, VCA typically reshapes inefficient operations to fit its own operating plan. In the process, the management team squeezes more juice out of each asset.
In its most recent quarter, VCA posted 17.7% revenue growth on a 17.4% increase in lab revenue (that's laboratories, not Labradors) and 17.5% animal-hospital segment growth. Acquisitions aided hospital growth significantly, but on a same-hospital basis, revenue still grew an impressive 6.6%. Continued operating leverage helped margins expand, and the company earned $0.42 a share, $0.02 greater than analysts expected.
Management also raised its full-year guidance, hiking the revenue outlook to a range of $1.14 billion-$1.15 billion, from $1.08 billion-$1.09 billion. Earnings expectations increased to $1.35-$1.37 a share, from $1.31-$1.35.
The larger VCA grows against unaffiliated rivals, the greater its economies of scale increase. For example, you may have learned your neighborhood veterinary hospital's location by haphazardly driving by it on your way home one day. That hospital's customer base is probably made up of people just like you, drawing customers from a limited geographical area. But a larger company like VCA Antech has the ability to leverage capital to advertise, drawing customers from a greater distance. It can also build brand appeal, winning clients via reputation, and save money by purchasing supplies in bulk at discount. Mom-and-pops just can't compete against that.
VCA trades at a P/E of 30 times its trailing-12-month EPS and 26 times my forward estimate of $1.51 for the next four quarters. The company's earnings have grown at a 26.5% average annual pace over the past five years, but analysts have forecast a 16% pace for the next five. A downshift in speed makes sense; the organization will logically become less nimble as it grows larger. Still, I'll bet that VCA's growth estimate five years ago was probably also far lower than the 26.5% the company actually achieved.
In short, the estimates are probably conservative. Consensus calls for just 15.7% growth in 2008; that's coming off this year's 20.7% estimate, and it seems to discount the large acquisitions VCA has undertaken. Heck, with only one month's contribution from the acquired 44 hospitals of Healthy Pet, the company managed 20% EPS growth. I'd apply a 20% growth forecast here to the forward P/E estimate of 26 times, and consider that conservative. That gives the company a PEG of 1.3 -- not bad for the quality and reliability of the earnings VCA offers, especially in today's environment.
Fool contributor Markos Kaminis has no ownership interest in any of the companies discussed here, although he once followed VCA Antech as an analyst on Wall Street. In addition to writing for The Fool, he runs his own financial blog, "Wall Street Greek." The Fool's disclosure policy makes sure Timmy stays out of the well.